We assess the prospect of a sharp economic slowdown in China as our top risk scenario.
Analysis
Continued deterioration in the country's services and manufacturing sectors, the ongoing build-up of the country's debt stock (which is now equivalent to some 240% of GDP), and continued capital outflows have highlighted structural weaknesses in the economy and resulted in a (market-driven) depreciation in the renminbi's exchange rate against the US dollar. The government's means to revive economic confidence are limited. Its huge fiscal stimulus in 2009 led to a build-up of bad debt that it is still seeking to curtail (especially in local government), and, despite the People's Bank of China burning through US$108bn of reserves in December alone, the renminbi has continued to weaken. Meanwhile, poorly managed official attempts to shore up the stockmarket have highlighted concerns that the government's promise to put a floor under economic growth might not be credible - as well as showing the shallow nature of the government's commitment to allowing market forces to play a role in raising productivity.
Conclusion
If China's economy slows by more than we currently expect, it will further feed the ongoing global commodity price slump (especially in oil and, in particular, metals), with a hugely detrimental impact on those Latin American, Middle Eastern and Sub-Saharan African states that had benefited from the earlier Chinese-driven boom in commodity prices. In addition, given the growing dependence of Western manufacturers and retailers on demand in China and other emerging markets, a prolonged deceleration in growth there would have a severe knock-on effect across the EU and the US - far more than would have been the case in earlier decades.
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